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How can oil prices be negative?

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A sign displays gas prices at a gas station in the Brooklyn borough of New York, the United States, on April 20, 2020. U.S. oil prices crashed to the negative territory for the first time in history on Monday, fueled by pandemic-related demand shock and oversupply fears. The West Texas Intermediate (WTI) for May delivery shed 55.9 U.S. dollars, or over 305 percent, to settle at -37.63 dollars a barrel on the New York Mercantile Exchange, implying that producers would pay buyers to take oil off their hands. (Photo by Michael Nagle/ Xinhua)

AFP – While a fall in oil prices is hardly a surprise after Coronavirus lockdowns hit demand just as producers had hiked production in a war for market share, how could they go negative?

Many no doubt thought there had been a glitch when the May futures contract for US benchmark West Texas Intermediate (WTI) closed Monday in New York at minus $37.63.

So crude oil producers were willing to pay someone to take the product off their hands.

How could this happen?

The May WTI contract plunged as the contract expires on Tuesday when the owner of the contract is technically supposed to take delivery of the crude.

And that is the problem: The oil storage terminal in Cushing, Oklahoma where WTI is delivered is nearly full given the ample US production and refineries slowing their output as gasoline demand drops.

Meanwhile, pipeline capacity to get it out is limited.

“The oil price reflects the economic value of oil less than the cost of storing oil,” said Stephen Innes, chief global market strategist at AxiCorp.

“As WTI requires physical delivery and storage is very expensive to access, the cost of storage in May exceeded the economic value of oil in May.”

Thus traders were ready to pay others to take it off their hands. Other US oil contracts turned negative recently as storage options run out. The crash also called attention to the fact that most oil trading is in futures, not physical barrels of oil. This means that the delivery of the commodity is carried out at a later date. Futures trading help market participants by allowing them to lock into prices.

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